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Gains in resources lift JSE

At 12:00 on Thursday, the JSE All Share had edged up 0.56% with gains in resource shares leading the upward trend.

The rand was exchanging at R6.95 to the US dollar at noon, weakening slightly after its recent strength.

Brent crude oil rose 5.18% to $79.94 a barrel, and is expected to finish September at a 7-month high after US inventories fell and a weaker dollar boosted the commodity.

International markets

Yesterday on US markets, investors prepared themselves for increased volatility as the best quarter in a year comes to a close. The Dow Jones edged down 0.21% and the Nasdaq gave up 0.13%.

The Japanese Nikkei index fell 1.99% this morning due to a rising yen, but further losses were limited by hopes that the government will once again intervene and central bank will continue to easy monetary policy.

In Hong Kong, the Hang Seng dipped 0.09% at its close after Goldman Sachs sold a $2.25 billion stake in Industrial and Commercial Bank of China Ltd.

In Britain, the FTSE 100 had lost 0.26% by noon as losses in bank shares weighed after news of a price on the Anglo Irish Bank bailout, and Moody's downgraded Spain's credit rating.

The outlook for emerging markets

Just as we are seeing a shift in reserve currencies, so there is a massive flow of investment money continuing to move to emerging markets.

Jim O Neil of Goldman Sachs originated the acronym BRIC – for Brazil, Russia, India and China in 2001 remains positive on the outlook of these countries.

In a report earlier in the year, Goldman Sachs outlined some of their views including:

• Over the past 20 years, the BRIC countries have contributed over a third of world GDP growth and grown from one-sixth of the world economy to almost a quarter in PPP terms (purchasing power parity). They expect the trend to continue and become more pronounced.

• Their baseline projections envisage the BRICs as an aggregate overtaking the US by 2018

• In the next decade the more striking story will be the rise of the new BRIC middle class. The report said that in the last decade alone the number of people with incomes greater than $6000 and less than $30 000 has grown by hundreds of millions and will rise even further in the next decade.

Performance

There can be no doubt that over the last ten years, the BRIC countries outperformed developed markets as is clear merely from the chart below of the respective equity markets.

Also telling is the substantial gain in emerging market equity capitalisation from $2 trillion in 2000 to $14 trillion today, while developed market capitalisation has only increased from $29 trillion to $30 trillion. According to Goldman this is a shocking statistic because by all accounts the market capitalisation of emerging markets should have doubled, not increased sevenfold.

But they go on to say:

• While BRIC equity markets may continue to do well, some factors that led to this extraordinary outperformance are less clear now.

• If one believes in the immense potential of rising consumer demand in BRIC, this will help support market performance over the next decade.

• But on the other hand, markets generally tend to award growth stories most when they are much better than expected. In the past decade BRIC equity markets outperformed significantly because the strong growth surprised many. At the same time valuations were low relative to the very frothy valuations that existed in many major markets in 2000.

They went on to conclude. Now that the BRIC story is better known, expectations are higher and the valuation gap is much smaller, the same degree of outperformance seems much less likely, even if the BRICS deliver solid returns.

The next 11

In late 2005, Goldman Sachs extended the BRIC theme to include the N-11 (the next 11) emerging market countries, being Bangladesh, Egypt, Indonesia, Iran, Korea, Mexico, Nigeria, Pakistan, Philippines, Turkey and Vietnam.

The FT reports “… Mr O’Neill [of Goldman Sachs] freely admits there was “no great science” behind the creation of the Next 11 universe – he simply listed the 11 most populous emerging markets after the Brics.”

“It was never intended to be anything like the Bric thing. I regarded the Brics as four integral parts of the world economy. I wouldn’t say the same about all the Next 11 countries.”

Civets

Michael Geoghegan, chief executive of HSBC until March next year, coined this acronym which stands for Colombia, Indonesia, Vietnam, Egypt, Turkey and South Africa.

Creating demand for these emerging markets

The next step for these banks and other institutional fund managers, once they start to push a theme, is to create funds that can mimic the performance across the selected country markets.

In a more recent Goldman report, it is estimated that developed market institutional asset managers currently hold 6% in emerging market equities within their total equity portfolio and that this weighting may rise to 10% by 2020 and 18% by 2030, implying net purchases of $4 trillion over the next 20 years.

Fund tracker, Lipper said this month that assets in emerging market bond funds swelled by 42% in 2009 to €63,2 billion, but that this growth pales when taking into account growth in the first 7 months of this year to July with a further rise to €96.4b billion

In short there is a lot of demand for emerging markets, evidenced in the sheer scale of the money flows and the exchange rates.

But not everyone is convinced.

A warning from Michael Lipper, president of Lipper Advisory Services and creator of the Lipper Growth Fund index, in a an article this week titled, “Why I am cautious on crowded emerging markets”

He noted that while he has generally been a successful global investor, he is raising the yellow flag of caution now, simply because it’s getting crowded out there. He cited 3 flags.

• The sheer scale of the money already invested into emerging markets, combined with large amounts being shifted from US Diversified equity into emerging market funds and emerging market ETF’s (exchange traded funds). He says that ETF money is typically more speculative in nature.

He is particularly concerned with the daily liquidity provided on these ETF funds, which “If some negative news event causes a redemption run on an ETF, they will have to sell some of each position.”

Of the top 25 largest SEC open ended mutual funds, there are 5 ETF funds, 2 of which are invested in emerging markets with a value of $70 billion.

• His third warning flag is anecdotal. A marketer of a major fund tells him how well sales of international and emerging markets are doing. A retired international investor is being pitched to go back into business focusing on frontier markets and other institutions starting infrastructure and frontier funds.

Lipper concludes that as a contrarian bet, he would look to large US growth funds with a lot of attractive companies in their portfolios at reasonable prices.

Only time will tell, but a recommended approach would be that as emerging markets become more popular, adopt a contrarian style and look to steadily increase your offshore exposure.

Weaker US dollar sees gold reach lifetime high

The JSE All Share had risen 0.54% by midday on Wednesday, with gains in the oil and gas sector leading the local bourse upwards.

The rand was trading at R6.95 to the US dollar at noon, looking to reach the R6.90 level as the dollar weakens further.

Gold cost $1 308 an ounce at 12:00 after reaching a lifetime high earlier, as the dollar weakened against several currencies on possible moves by the US Federal Reserve to help strengthen economic recovery.

International markets

Yesterday on US markets, the Dow Jones edged up 0.43% while the Nasdaq rose 0.41% after investors bought outperforming shares.

Japan’s Nikkei average closed up 0.67% this morning before the end of the first half of the financial year, but further gains were limited by the continued strength of the yen.

Pick N Pay Holdings Limited (PWK) fell to R17.20 a share at 12:00, a loss of 4.18% after 447 449 shares were traded in 137 deals. Pick N Pay announced this morning an expected loss in total HEPS of between 10% and 25%.

Also losing ground was Pick N Pay Stores Limited (PIK) after 1 360 025 shares were sold in 581 deals, which saw the share price drop 2.62% to R42.30 at midday.

Making decisions

Last week we highlighted in an article the different conclusions that one could come to on a fund, just by using different starting dates to measure performance of one fund against another of against the market. Often investors make decisions based on insufficient information, which can naturally be prejudicial to long term results.

Then even when all the facts are available, many investors make less than optimal decisions due to psychological factors.

Daniel Kahneman is a psychology professor at Princeton University and winner of the Noble Memorial prize in economics in 2002 for his work on prospect theory. This is a theory that describes decisions between alternatives that involve risk, where probabilities are known.

Traditional theory developed around making decision making with regard to uncertain outcomes was called the expected utility theory. Here individuals make decisions based on preferences and available information that changes little over time.

Essentially this theory says that where there is risk in an outcome, a decision maker would always opt for the choice that offered the highest expected value, taking probabilities into account.

The theory is great, but Kahneman and Amos Tversky developed their more realistic alternative theory to the more mathematical approach to decision making.

Through observations, the theory describes how individuals evaluate potential losses and gains. Some of the characteristics that lead investors into making sub optimal decisions include:

• Investors tend to be overconfident.

• Investors are often short-sighted, focusing on short-term gains and losses.

• Investors tend to segregate accounts rather than looking at overall wealth.

• Investors often sell the winners and hold the losers.

An investors attitude towards risk will have an impact on the sustainability of a developing a long term plan. Two investors can be identical in terms of age and financial position, but have a different makeup in terms of their outlook on risk.

While not easy or near impossible to quantify, this is important to take into account when developing a long term plan of action.

For example, most people have an asymmetrical outlook on gains or losses to their overall portfolio – but the magnitude will vary from investor to investor.

A typical investor’s emotion to positive returns and negative returns can be illustrated in the following graph.

The graph shows that with a 10% gain the level of “satisfaction” is minimal. However the level of “pain” someone feels for losing only say 7% is substantial.

At Seed we recognize this investor behaviour and the best way to manage this behaviour is to have clear indication what the level of risk is of the underlying portfolio.

At midday, shares in Jubilee Platinum (share code: JBL) rose 5.79% to R3.84, after 373 482 shares were exchanged in 43 deals. This morning, Jubilee reported that an increase of 50% to 70% in earnings per share is expected.

Once again amongst the top movers upwards was Litha Healthcare Group Limited (LHG) whose shares rose 2.45% to R1.67 at noon, after investors traded 256 521 shares in 47 deals.

Investment bank Cadiz Holdings Limited (CDZ) fell to R3.20 a share, a loss of 5.88% after 25 deals exchanged 121 132 shares. In a trading statement, Cadiz announced that EPS for the six months ended 30 September 2010 are expected to drop by at least 20%.

Avusa Limited (AVU) in the media agencies sector lost 3.14% after 4 deals traded 52 182 shares, with the share price dropping to R21.30 by noon.

Foreigners buying SA companies

In recent months there have been a number of foreign buyers concluding deals with local companies. There are naturally a number of reasons, some general and some specific. Local company excellence combined with global companies flush with cash has led some to South Africa looking for expansion opportunities.

A retail acquisition

There have been rumours for some time that Wal-Mart was looking for a large acquisition in South Africa. Massmart was one of the companies that the market considered as a good possibility

This morning, Massmart issued a cautionary saying that it has received a non binding proposal from Wal-Mart Stores (Walmart) which could lead to Walmart making a cash offer to acquire the entire issued shares at a price of R148/share.

The shares gained ground immediately jumping 12% to R152. Clearly at this price compared to the indicated R148, shareholders are looking for Walmart to up the price once it has completed a due diligence.

The cautionary says that while a period of exclusivity has been granted there is no certainty that discussions will lead to a formal offer being made.

At a price of R150, Massmart has a R30 billion.

An IT acquisition

On the 15 July, we had the same happening with Didata, when it announced that it had been negotiating with NTT (Nippon Telegraph and Telephone Corporation), which will see NTT buy out the total shareholding of Didata. The various regulatory hurdles are being cleared for this transaction to go ahead. Didata has a market capitalisation of R22,7 billion.

An Agribusiness acquisition

A private equity buyout that was announced 2 weeks back was Du Pont’s Pioneer Hi Bred buying a majority stake in local hybrid seed manufacturer, Pannar Seed, the largest independent seed group in South Africa. Du Pont is a large US based chemical company, founded in 1802 – the company is part of the Dow 30 companies that comprise the Dow Jones Industrial Average.

Pannar Seed, founded in 1958, is a major hybrid seed distributor. Operating from its head office in Greytown, KwaZulu Natal, it has operations across the world.

Although no value was announced, reports indicate that “the deal is one of the largest agribusiness deals in South Africa and is the largest external investment by Pioneer Hi Bred.”. It is subject to SA Competition Commission and other regulatory approval reviews and conditions and should be finalised

These deals, still to be finalised, give an indication that many businesses in South Africa remain attractive to foreigners looking for opportunities.

The rand remains at the R7/dollar level. It dipped below this level for a brief period today.

Gold traded around $1300/oz

The market was up, last trading up almost 1% at 28984. Financials were up 1,77%

JSE slides, lacking direction from global markets

The JSE All Share had fallen 0.24% by midday, with moderate losses across the board except for gold mining shares, which had gained 0.76% by lunch boosted by higher commodity prices.

The rand was trading at R7.07 to the US dollar at noon, weakening slightly as the local currency consolidated after reaching a high against the dollar on Wednesday.

Gold cost $1291.20 an ounce, inching up as safe-haven assets grew in appeal due to continued economic worries.

International markets

Yesterday, the Dow Jones fell 0.20% while the Nasdaq lost 0.63% after US markets took a hit from Adobe's pessimistic outlook and a lower-than-expected dividend from Microsoft.

The Nikkei, Shanghai and Hang Seng indices were all closed for public holidays today.

European shares continued to decline for a third session, as new economic data compounded worries about the strength of global economic recovery. France’s CAC40 had lost 0.92% and the DAX was down 0.71% around midday.

Britain's FTSE 100 had fallen 0.77% by noon, as banks continued to lose ground after anxiety over US economic recovery.

The carry trade

We see the rand trading at just below R7/dollar today. In other words it’s getting stronger and stronger, which negatively impacts exporters and positively importers. Gill Marcus is reported on Finweek as saying that there is “no easy answer” to the strong currency which is up 25% against the dollar since the start of 2009.

The rand is clearly not the only currency that has been gaining ground. A common blame lies with the so called carry trade.

What is the carry trade?

In the foreign exchange (forex) market, currencies are traded in pairs, so a trader is buying one currency and selling another at the same time. For example buy the USD and sell the Swiss Franc (CHF).

Interest is paid on the currency position that is being sold (in the example above, on CHF) and interest is received on the currency position that has been bought (USD). In effect the net interest rate differential is debited or credited to the trading account on a daily basis.

A trader will want to buy a currency that is yielding a high interest rate and sell or fund the buying leg with a currency that is yielding a lower interest rate.

With interest rates as low as 0,1% in Japan and 0,25% in the US – these make excellent currencies to sell in order to buy currencies such as the Australian dollar, New Zealand dollar, Brazil real and even the South African rand, where official interest rates are at .

The relatively low margins are enhanced by traders gearing up or leveraging these positions. Forex trading is almost completely margin based, which means that traders only have to put up a small margin of 1% - 2% to acquire a large exposure to a trade.

In addition to the carry trade, where the currency that was acquired moves up relatively to the currency that was originally sold, when it comes time to get out of the position, the trader makes an additional profit. Naturally it can move the other way, but ordinarily the sheer force of money moving in one direction, seems to push a currency in one direction for a period of time.

Global concerns about strengthening currencies

With the US and Euro maintaining ultra low interest rates with

• The Brazil central bank has been conducting two auctions a day to buy US dollars at an estimated amount of $1 billion a day over the last week.

• Possibly because the Australian central bank was the first to start raising interest rates, its currency has been hugely popular, with the Aussie dollar being driven up from 1AUD buying US0,65 in April 2009 to its current US0,95. With a high possibility that interest rates in Australia will rise again before the end of the year, the currency may soon trade at parity to the USD.

• While Japan continues to run ultra low interest rates, its currency has been appreciating relative to the USD to new 15 year highs.

With the yen at 15 year highs relative to the USD, Japan announced this month that it will once again try and depreciate its yen relative to the US dollar, in order to assist the export market. It last did this in 2004. They do this by buying dollars and selling yen.

Just how interconnected are the currency markets?

The interconnectedness of these markets is revealed in this possibility outlined by the G10 forex economist at Standard Bank.

With Japan selling yen and buying dollars, they are “handing the carry-trade community gift here”, because traders want to sell the funding currency where there is a low probability of it appreciating and offsetting the interest rate pick up. Traders will side with the authorities, sell the yen and buy the Aussie, Kiwi and Emerging market currencies like the Brazilian real.

Combine this with the US Federal Reserve that is signalling further monetary easing as a means to generate growth and inflation, and its no surprise that carry trades keep moving certain currencies up.

As the Standard Bank report mentioned though, there is always risk, and because of the leveraged nature of this type of trade, it does not taken much to have a quick sharp reversal of one currency against another.

Global markets lose ground on persistent recovery concerns

Wednesday at noon saw the JSE All Share down 0.36%, as losses in the oil, gas and industrial sectors weighed. Gold miners bucked the trend, gaining 0.87% by midday.

The rand was exchanging at R6.97 to the US dollar at 12:00, strengthening to a 2½ year high as the dollar weakened and investors await key economic data from the South African Reserve Bank.

Oil rose 6.77% to cost $77.94 per barrel, on persistent concerns for the US economy and worrying crude oil inventory levels.

International markets

Yesterday, US markets closed flat after a volatile session as the Federal Reserve inched closer to further steps to spur the economy. The Dow Jones edged up 0.07% while the Nasdaq lost 0.28%.

In Japan, the Nikkei average slipped 0.37% this morning, though losses were limited by a stronger dollar and expectations of further Japanese intervention if the yen strengthened further.

European shares continued to lose ground this morning, led by banks on continuing concern for the health of global economic recovery. Germany’s DAX had fallen 0.90% while France’s CAC40 had tumbled 0.96% around noon.

In Britain, the FTSE 100 had fallen 0.51% after losses in banks and energy stocks, after worries over the US economy.

On Tuesday at 12:00, moderate gains almost across the board supported a 0.16% gain in the JSE All Share, despite losses in oil, gas and resources shares. Investors traded cautiously ahead of a US Federal Reserve policy meeting and US housing data due this afternoon.

The rand was trading at R7.09 to the US dollar at noon, a little stronger before Ireland’s bond auction of up to €1.5 billion, and a meeting of the US Federal Open Market Committee later.

Oil cost $78.85 a barrel, gaining 2.40% despite initial caution ahead of the US monetary policy meeting. The meeting is expected to provide insight into the health of global economic recovery and the corresponding demand for oil.

International markets

Yesterday on US markets, the Dow Jones rose 1.37% and the Nasdaq lifted 1.74% as a wave of optimistic corporate news inspired investors to buy.

The Japanese Nikkei index fell 0.25% this morning, as investors took profits after the yen’s continued strength against the dollar dampened sentiment.

In Germany, the DAX had risen 0.47% while France’s CAC40 had gained 0.61%, with mining shares leading the upward trend. Further gains were limited by caution ahead of today’s US Federal Reserve meeting.

Britain's FTSE 100 had edged up 0.45%, as gains in bank and energy shares continued yesterday’s rally.

Mazor Group Limited (MZR) in the construction materials sector fell 5.71% after 176 532 shares were traded in 17 deals, leaving the share price down at R1.65. Mazor released a trading update this morning, announcing a 70% decrease in EPS and HEPS for the six months ended 31 August 2010.

After 34 deals of 1 670 466 shares, DRDGold Limited (DRD) lost 1.65% as shares fell to R3.57 each at midday.

The equity risk premium

In periods of uncertainty, general pessimism and investor nervousness, risky assets are sold and money moved to “safer” investments.

It is at these times that investors require a higher premium for investing in so called risky assets, compared to typical lower risk investments such as government bonds. It is this extra return that compensates an investor for taking on the “additional risk” of buying into the ordinary shares of a company.

An article in the finance section of weekend paper discussing property syndication, Sharemax, discussed the concept of being paid for risk succinctly, when it said, “However, what many pensioners do not realise is that every percentage point above the acceptable market rate [government bonds] multiplies the risk.”

Investors understand that they need to be rewarded for taking on additional risk, but as the chart below clearly indicates, the equity risk premium is never a fixed percentage and indeed never a given. Measured historically over the very longer term, the premium is around 7%, but it has varied widely.

For example, in the decade run up to March 2000, investors were prepared to accept less and less of a premium over risk free bonds for the opportunity of owning ordinary shares in a company. They were prepared to do this because prices were moving up and it was a case of buying expensively, because tomorrow it will be even more expensive.

The result – prices moved up to excessive valuations. Subsequently investors suffered a 10 year run of ultra low returns from these high starting values.

Prices moving sideways over this part 10 year period has led to a normalisation of the equity risk premium. According to Ashburton, their estimate of the implied US equity risk premium has steadily risen back to almost 7% on forecast earnings. This is suggesting that the market as a whole is taking a more pessimistic outlook towards equities as an asset class, compared to a few years back.

Its in this type of environment, where prices are back at more normalised levels, that investors are indeed potentially being rewarded for taking on additional risk.

Sure, there is an argument that says that the world has changed radically over the past 10 years and the normal required equity premium should be much higher, but these levels of higher implied risk premium do point to higher prospective returns from global equities, compared to the past 10 years.

Visit the trade section on Sharenet for details on the services and funds that Seed provides.

Fundamentals versus Technicals

Seed is an investment company that places a large emphasis on valuations when making investments on behalf of our clients. We believe that (and this is Warren Buffett quoting Benjamin Graham) “Investment is most intelligent when it is most businesslike” and buying assets at an appropriate price is therefore crucial to our investment strategy.

While we are focused on the fundamentals when making investment decisions we don’t completely rule out other aspects that could influence investment performance. Economic considerations can be important from time to time and technical indicators can prove to be quite prescient over various time periods.

When the different elements agree with each other there is be good reason to believe that we can place a higher degree of confidence in the research’s output. When there are conflicting outputs we need to investigate why this is the case. From here we can then make informed investment decisions.

Currently we have the case where on a fundamental basis (using Purchasing Power Parity (PPP)) the rand is too strong versus the US dollar, but technicals paint a different picture. The charts below illustrate the different conclusions.

PPP essentially states that the movement between exchange rates should be explained by the inflation differentials of the two regions. As can be seen from the first chart this relationship generally holds true over the longer term. Having said that there are long periods where the rand can be under or overvalued. Just because the rand is strong now, doesn’t mean it’s going to weaken in the next week or month, but if you consistently position your portfolio to take advantage of the deviations from the PPP level you should produce alpha over time. On a PPP basis the rand should be trading around R8.60 against the US dollar.

On a technical basis the JP Morgan analyst shows how R7.187 is a support level, and that should the rand stay below this level it could well test R6.90 and R6.50 versus the US dollar. On a historic basis we can see that such deviations from the trend aren’t without precedent, so there might be some merit in this analysis.

Ultimately one method will triumph over the other. In the short term there is perhaps greater support on the technical side, but over the longer term we believe that there is a higher probability that the rand will depreciate against the US dollar. We have thus positioned our client portfolios to take advantage of the longer term trend of rand weakness. We believe that while you can potentially use shorter term indicators to time entry and exit points, the best indicators are ones that have a longer term focus.

JSE lower in line with international markets

Local markets

Thursday at noon saw the JSE All Share down 0.04% in line with losses on global markets. Financial shares led the downward trend, though gains in gold miners and oil and gas stocks limited losses overall.

The rand was exchanging at R7.09 to the US dollar at 12:00, easing slightly after its recent rally and as traders looked to the euro for direction.

Oil was selling at $78.49 a barrel, up 0.63% at midday. US regulators agreed to Enbridge’s request to restart the biggest Canadian-US pipeline on Friday.

International markets

The Dow Jones rose 0.44% and the Nasdaq gained 0.50% yesterday, though US stocks remained in a range after disappointing economic data.

Japan’s Nikkei closed 0.07% lower this morning, as the government’s intervention did not weaken the yen as much as hoped.

After 7 deals traded 151 500 shares, Country Bird Holdings Limited (CBH) in the farming and fishing sector rose 2% to sell at R2.55 a share.

Investec Limited (INL) fell to R56.19 a share, a loss of 2.26% after investors sold 214 921 shares in 371 deals. Investec issued a pre-close briefing this morning, reporting a delay in the improvement of the level of non-performing loans and an increase in the number of defaults.

Investec PLC (INP) lost 2.42% to trade at R54.94 a share, after 1 079 829 shares were exchanged in 622 deals by midday.

The JSE Industrial index

The JSE Industrial 25 index has moved up to new all time highs this last week. When comparing industrials to the JSE index over the last two years it is clear that over the last 12 months industrials have outperformed the market. One possible reason is that the overall market has a higher weighting to rand sensitive resource shares, with the firm rand not impacting local industrials to the same extent as resources.

The chart below reflects the relative performance of the JSE Industrial 25 index to the JSE All Share index over the past 2 years.

JSE Industrial 25 index compared to the JSE All Share index

An index comprises a number of underlying companies – in the case of this index, 25 large cap industrial shares. As always, there is a combination of expensive and cheap shares.

Looking at these companies, most of which have now reported results for the past 12 months, and tabling the historical and 12 months forward price to earnings ratio, the simple (i.e. non weighted) historical PE ratio is 19 times, while on a forward basis this should reduce to 13 times.

While a PE ratio makes for easier comparison of one company against another, there are many factors that can justify differing ratios. These include important aspects such as the company’s return on equity, its dividend payout ratio, and required rates of return.

Clearly the market is placing a premium on certain well run companies like Aspen, Massmart, Naspers, Pick n Pay, SABMiller, Shoprite, and Truworths for example.

Shoprite is trading on a forward PE of almost 20 times, while Steinhoff trades on a forward PE of just 7 times. Time will tell whether the current valuations are justified.

The Seed flexible unit trust fund owns 4 of the shares in this index. This fund is aimed at investors seeking a balanced fund. Visit the Seed Investments website for further details or don’t hesitate to contact us directly.

Losses in gold miners lead JSE down

The rand had steadied at R7.08 to the US dollar at noon, with analysts anticipating the local currency to test the key R7 level after reaching its highest rate since 2008 yesterday.

Gold cost $1 269 an ounce, edging up 0.07% after yesterday’s record high. Analysts expect gold to strengthen further as worry over global economic recovery continues.

International markets

On US markets, the Dow Jones lost 0.17% while the Nasdaq gained 0.18%. Investors are still mulling over potentially positive data from the retail sector which suggests that economic recovery continues, though slow.

The Nikkei index closed 2.34% higher this morning, after the government intervened to weaken the yen, boosting shares of exporters.

European markets were flat this morning as investors considered the impact of Japan’s intervention in the yen. Germany’s DAX was 0.21% lower while France’s CAC40 had slipped 0.14% by midday.

Britain's FTSE 100 had given up 0.15% by 12:00, as investors cautiously awaited local unemployment figures and euro zone inflation figures due this afternoon.

Sasol results

Sasol, the sixth largest company listed on the JSE, by market capitalisation released its annual results today. Sasol is a share in many investors’ portfolios and also via funds. The key drivers of the Sasol earnings are the oil price and the rand exchange rate. While oil firmed, the strong rand took away a lot of the shine.

The consensus earnings for Sasol was 2659c for June 2010. The company had provided guidance at the beginning of August of between 0% and 8% and actual headline EPS gained 5% to 2657c.

Actual reported earnings came in at R26,68/share and the company was able to raise the dividend by 24% to R10,50. This too was higher than the forecast of R9,72/share. The price gained 3,6% to R300.

At this price it now trades on an historical price to earnings ratio of 11,2 times against the overall market PE ratio of 16,5 times. The dividend yield is 3,5% against a yield of 2,3% for the market.

In May 2008 the price of Sasol moved through the R500/share level before falling back to below R220. At its peak the price of crude was moving up through $140/barrel, before falling sharply to below $40/barrel.

Now the share price has picked up but generally moved sideways for 2 years to its current level of R300, while the price of oil has been moving up steadily to its current $78/barrel.

However the other factor driving performance is the rand, which has strengthened by 16% over the financial year.

Attributable earnings grew from R13,6 billion to R15,9 billion. Cash flow from operations however fell from R48billion to R27,3 billion, due to an increase in working capital. The company has a high capital expenditure requirement, with capital spend at R16 billion for the year. The estimated spend in 2011 is a further R19 billion.

The biggest division by operating profit is Synfuels, but its profit fell from R25,1 billion to R13,1 billion, a drop of 48%. Production volumes were 3,9% higher and unit cash costs were down 5,8% mainly due to not taking all shutdown expenses to the income statement. The big decline was therefore due to the firm rand against the US dollar. Also included in 2009 numbers was a R4,9m profit due to the oil hedge, which was not repeated in 2010.

The more astute investors are moving back into Sasol at these attractive absolute and relative valuations. Clearly it has upside to a weaker rand, which although extremely strong now, could weaken on any increase in global risk.

Positive data from the US and China boost global markets

At 12:00 on Monday, stronger resources and basic materials shares led the JSE All Share higher by 0.98%.

The rand was trading at R7.13 to the US dollar at noon, its firmest level in two-and-a-half years as the local currency followed a strengthening euro.

Oil cost $77.92 a barrel at midday, rising 1.19% on growing Chinese demand and output, and the continued closure of a major pipeline between the US and Canada.

International markets

On Friday, US markets closed higher on expectations of an improved economic outlook after data showed that US wholesale inventories rose the highest in two years in July. The Dow Jones gained 0.46% while the Nasdaq edged up 0.28%.

The Japanese Nikkei climbed 0.89% this morning to reach its highest close in three weeks, after positive economic data from China and the US boosted sentiment.

Is there absolute value in global large cap shares?

It is very evident that investors in global shares have experienced poor performance over the last 10 years. The FTSE world index gained just 2,9% over the last 12 months and just 0,6% per annum over the last 10 years.

Dow Jones Industrial Average

Ten years ago the Dow Jones industrial average index was trading around 11 000. Now it’s around 10 400. Investors have suffered one of the worst 10 year performances, but as is often the case, this creates the foundation for a possible outperformance over the next 10 years.

The Dow Jones Industrial Average is an index made up of 30 large US companies, including the likes of American Express, Home Depot, IBM, Johnson and Johnson, Microsoft, AT&T, Wal-Mart and MacDonald’s.

The question then is why did these large companies produce such a poor 10 year performance? The answer lies in the starting valuation. A long term chart of the PE ratio gives a clear indication of how expensive the market got to in 1999/2000, where prices were trading in excess of 25 times earnings.

Dow Jones annual PE ratio

Now ten years later, there are many indications that global large capitalisation shares are trading at valuations that represent good absolute and relative value.

The current trailing price to earnings ratio is 14 times and one estimate has the 12 months forward PE at 12,5 times.

A sample of large cap global companies is provided in the table below.

Chart of selected global companies

Data source : Yahoo finance

By way of comparison, a local value fund manager has a South African portfolio with a forward PE of 8,9 times and a forward dividend yield of 4,2%.

It is therefore quite instructive that an investor can construct a global portfolio of high quality companies with a forward valuation of just 10,7 times and a similar forward dividend yield to that of a local value portfolio.

An environment which has provided a low historical return combined with high current perceived risk is providing this opportunity for value investors.

"There is a big disconnect out there," says Swanson, chief investment strategist at MFS Investment Management. "People don't want to buy Johnson & Johnson, even though it's trading at 12 times expected earnings with a dividend yield of 3.7%."

One global fund manager, Bill Miller, chairman and chief investment officer of fund managers Legg Mason Capital Management, concluded an article in the Financial Times at the end of August with the following:

“The point here is simple: US large capitalisation stocks represent a once-in-a- lifetime opportunity in my opinion to buy the best quality companies in the world at bargain prices. The last time they were this cheap relative to bonds was 1951. I was one year old then, but did not have sufficient sentience to invest. I do now, and if you are reading this, so do you.”

With prices down, yields on shares are up. When measured against 10 year Treasury yields as in the chart below, it’s evident that investors can buy global companies at similar dividend yields. We are moving back to the environment that says “an investment into equities carries risk; therefore I require a higher dividend yield than bonds to compensate me for this risk.”

Source: Seeking Alpha

This does not mean that investors will be immediately rewarded with prices going up, but longer term investors will do well to buy into quality with a ten year investment outlook.

Don’t hesitate to contact Seed Investments to discuss how we can assist with your retirement planning and investment management.

On Thursday at 12:00, small gains almost across the board saw the JSE All Share rise 0.51%, recovering after losses earlier in the day.

Top of Form
The rand was trading at R7.23 to the US dollar at noon, remaining at the low end of its range as investors await the outcome of today’s MPC interest rate decision.

Brent crude oil rose 0.35% to cost $77.27 a barrel, after an initial report of falling US inventories boosted prices.

International markets

Yesterday, the Dow Jones finished 1.03% lower while the Nasdaq gained 0.9%. Investors were caught between positive news from Europe and indications that US economic recovery was slowing down, resulting in mixed markets.

The Japanese Nikkei closed 0.82% higher this morning, as short-covering after successful bond auctions in Portugal and Poland that eased European debt worries, boosted the index.

China’s Shanghai index fell 1.44% after a surprise drop in commodities futures and the forthcoming release of more economic data spurred profit taking.

Britain's FTSE 100 had edged up 0.77% by noon, after rising bank shares offset losses in retail shares after pessimistic remarks from Home Retail and WM Morrison Supermarkets.

Falling 1.11% to R23.97 a share, Sanlam Limited (SLM) saw the trade of 1 821 040 shares in 611 deals. Sanlam released their interim results today and announced the settlement of disputes on pension fund surpluses.

Computer services company Dimension Data Holdings Limited (DDT) fell to R13.30 a share, a loss of 0.67% as 175 607 shares were traded in 20 deals.

Interest Rates Hit 3 Decade Lows

It had become quite apparent over the past few weeks that the MPC would drop the repo rate by at least 0.5% (50bps). The questions then become, will it only be 50bps, and will this be the last cut in the cycle? Gill Marcus confirmed that there will indeed be a 50bps drop in the repo rate, which will lead to a 0.5% fall in the prime lending rate, but opinions are divided on whether this will be the last cut in the cycle, despite interest rates being at their lowest since 1974!

Changing interest rates (up or down) always results in vested parties feeling aggrieved. Typically rising interest rates are denounced by labour unions as rising interest rates are associated with job losses (as companies struggle to pay off old debt/take on new debt). Undoubtedly low interest rates are good at spurring economic growth and job creation, but a negative spinoff often associated with lowering rates is high inflation which eats at good nominal growth.

Falling rates are generally condemned by those citizens living off a fixed saving. Falling rates mean that these ‘investors’ receive less income by way of interest, and they therefore need to make the decision to cut their standard of living or eat into their capital. Neither is an easy choice.

To mitigate the risk of interest rates falling, retired investors need to ensure that they have an allocation to growth assets. Each investor should have a target weighting to more risky growth assets depending on their circumstances. Growth assets usually perform better when interest rates are lower. This results in a natural hedge when looking at a complete portfolio. The reality these days is that investors can live in excess of 30 years after they retire and investment strategies should therefore be devised to take this increased longevity into account.

The MPC, in coming to a final decision, need to take all stakeholders into account.

The chart below shows how interest rates and inflation typically move in similar cycles. Also interesting is that there is quite a high correlation in the movement of these indicators and the US dollar exchange rate with the rand. This comes as a result of imported inflation/deflation.

A higher exchange rate results in higher prices of imported goods, which pushes inflation up. Increased inflation results in the MPC increasing interest rates to dampen demand. Naturally you can see that many of these economic variables are highly interconnected. When making decisions one needs to take into account all consequences of that decision.

If we are to see a further cut in interest rates we’ll need to see the following conditions satisfied between now and the next meeting in November:
• Weak economic growth
• Low(er) inflation
• A strong rand

If you need assistance with structuring your portfolio in a low interest rate environment contact us at the details below.

Improved news section

Sharenet has improved its news section dramatically by developing a dedicated news page that allows users to group news according to the following categories:

Local SA business items, US business, African news, European news, Asian headlines, breaking FOREX-related news and international breaking stories. Our SENS items can still be located in the SENS news section and remains unaffected by this change.

To further aid our readers we have added keyword search functionality and we will continue to ensure that the most up-to-date and helpful news is displayed in the relevant categories. Try it out by clicking here

Sharenet sources its news from Reuters and company results news from Profile.

Possible changes in the investment advice industry

The financial industry is as ever changing. It is interesting to note how the business case for advisors has changed over the past 20 years. It is important for the general public to understand this change because it will impact the type of advice they get and the type of solutions that they will buy.

20 years ago financial products were mostly sold by a few large institutions through their broker force. This was an ideal method for large corporates to get their products out to the general public. The owners of these products (mostly life companies) ensured that the broker force sold the products on the terms they laid down. As a client you knew that by going to a broker that was “tied” to company XYZ you were only going to receive products from company XYZ. There is nothing wrong with this model as long as the broker explained it and as long as the client understood it.

Life companies then started to distinguish between their life insurance and their asset management businesses. This started the process where we saw the inception of new asset managers that were not linked to life companies. These asset managers generally sold their products i.e. unit trusts, endowments, retirement annuities etc through the independent advisor channel. As more and more asset management companies were formed the credibility of the independent advisor improved. Today we have a healthy “tied” broker channel for the large companies and a healthy independent advisor channel that advises and sells a broad range of financial products. You also have a mid-range advisor that is semi-tied to one institution but can also advise and sell other products.

Again, clients need to understand who they are dealing with because it will impact the type of products that will be presented to them.

Over the past couple of years we have seen an exponential growth in the volume of legislation and compliance that brokers and advisors need to comply to. Obviously this raises the quality and credibility of the financial industry and ultimately it offered a better service to the end clients. However, this has resulted in a huge financial expense on the part of the independent advisor. In many cases this cost is becoming unaffordable to many independent advisors.

What is likely to happen in the near future as a result of these additional expenses and legislation?

1. We will most likely see fewer independent advisors and more brokers “tied” to one or two institutions.

2. We will most likely see more independent advisors joining hands to unlock the economies of scale in their businesses.

3. Advisors in Australia and the UK have started giving advice on a “fee for service” basis similar to a doctor’s model i.e. only paying for the service you get. This is likely to happen in SA in the near future.

4. Because of the extra legislative and compliance cost you will find that independent advisors focus more on higher net worth clients and will ultimately stop giving advice to the smaller clients. It will just become unprofitable to give advice to smaller clients.

5. Because of point 4 we will most likely see asset managers filling this “advice gap” with technology that the younger generation (Gen X and Y) can use to assess their needs instead of going to an advisor or broker.

As mentioned above, it is very important for clients to have a clear understanding of who they are dealing with. Over the longer term the cost of dealing with advisors will decline, as has the cost of brokerage over the years.

Advisors and fund managers will need to adapt their business model, but at the same time look to continually improve the service to their clients.

JSE retreats on pessimistic global sentiment

At midday on Wednesday, the JSE All Share had slipped 0.13% in line with weaker global markets, despite earlier gains in resource and gold mining shares after firmer metals prices.

The rand was trading within a range at noon, exchanging at R7.27 to the US dollar ahead of tomorrow’s interest rate decision by the Monetary Policy Committee.

Oil cost $76.33 a barrel at 12:00, recovering 0.21% after falling for three sessions as the commodity took a hit from lower equity markets.

International markets

On US markets yesterday, the Dow Jones fell 1.03% and the Nasdaq gave up 1.11% after revived concerns about European banks spurred selling.

In Japan, the Nikkei average lost 2.18% this morning after the yen strengthened to a 15-year high against the dollar, and sent investors running for cover.

Hong Kong’s Hang Seng fell 1.46% at its close, ending a five-day rally after Vodafone sold its stake in China Mobile at a discount, sending China Mobile shares plummeting.

Britain's FTSE 100 had lost 0.66% by midday, after banks lost ground on worries over European banks, and mining shares continued to be shaken by concern over Australia's tax plan.

Share price news

Petmin Limited (share code: PET) released their preliminary consolidated results, and announced a maiden dividend this morning. The share price climbed 4.17% to R2.50 in response, after 192 250 shares were traded in 29 deals.

Onelogix Group Limited (OLG) rose to R1 a share, a gain of 2.04% after investors sold 624 847 shares in 10 deals.

JSE slides as international markets weaken on profit taking

On Tuesday at noon, the JSE had slipped 0.51% led by losses in the oil and gas index. The local bourse was influenced by weaker international markets as profit taking set in after recent gains.

The rand slipped to R7.26 against the US dollar as investors were cautious ahead of a rate cut due later this week.

Gold fell 0.28% to $1246.50 an ounce at midday, as dollar strength limited gains after revived concern for the European banking sector and global economic growth.

International markets

US markets were closed yesterday for a public holiday.

Japan’s Nikkei average fell 0.81% this morning, as investors took profits after recent gains, and as the yen remained strong.

Hong Kong’s Hang Seng gained 0.22% at its close to continue its recent rally.

England’s FTSE 100 was down 0.83% at noon as losses in banks weighed after renewed concern about the health of European banking sector.

Share price news

At midday, Metorex Limited (share code: MTX) rose to R3.74 a share, an increase of 2.75% as 1 562 840 shares were traded in 176 deals. Metorex announced their interim results this morning, reporting an increase in both copper and cobalt production.

JSE slides as international markets weaken on profit taking

On Tuesday at noon, the JSE had slipped 0.51% led by losses in the oil and gas index. The local bourse was influenced by weaker international markets as profit taking set in after recent gains.

The rand slipped to R7.26 against the US dollar as investors were cautious ahead of a rate cut due later this week.

Gold fell 0.28% to $1246.50 an ounce at midday, as dollar strength limited gains after revived concern for the European banking sector and global economic growth.

International markets

US markets were closed yesterday for a public holiday.

Japan’s Nikkei average fell 0.81% this morning, as investors took profits after recent gains, and as the yen remained strong.

Hong Kong’s Hang Seng gained 0.22% at its close to continue its recent rally.

England’s FTSE 100 was down 0.83% at noon as losses in banks weighed after renewed concern about the health of European banking sector.

Share price news

At midday, Metorex Limited (share code: MTX) rose to R3.74 a share, an increase of 2.75% as 1 562 840 shares were traded in 176 deals. Metorex announced their interim results this morning, reporting an increase in both copper and cobalt production.

Where is value starting to appear?

The strong rand and low inflation numbers provide a perfect opportunity for the Reserve Bank to lower interest rates this week. The majority of economists are now predicting that local interest rates will come down by a further 0,5% this week. The bullish outlook has driven foreigners to have now reportedly acquired over R70 billion in local bonds on a net basis in 2010.

With the rand at an incredibly strong R7,20 /dollar and local investments having outperformed foreign investments over the last 10 years, the crucial question for local investors is whether it even makes sense moving funds offshore.

Bill Miller, chairman and chief investment officer of US based asset management firm Legg Mason, made some interesting observations in a FT article last week, headed “US large-cap stocks are bargains of a lifetime.”

Against the backdrop of a weak economic outlook making such a prediction goes against the prevailing sentiment.

He noted that “Using the outlook for the economy to predict the direction of the stock market, which most appear to do, is to look at things the wrong way round.”

Markets are all about expectations and the critical question for investors is always, what is discounted?

There is a heightened bearish outlook for equities. This is understandable given a period of 10 years where investors in US shares have experienced negative returns. At the same time he notes that so called “riskless” US treasuries have soared in value as interest rates have kept coming down.

His article discussed how even extending this back in time, the Barclays Capital Long Term Treasury Bond total return index, has beaten equities as measured by the S&P 500 in the year to date, and in the 3-, 5-, 10-, 15-, and 20-year time frames. Over 25 years it’s a tie.

In other words now more than even investors are questioning the merits of owning US shares rather than bonds. When looking over a 10 year period they see the clear advantage that emerging market equities had over developed market equities.

This bearish outlook only lowers the valuations for global equities, and specifically US shares. It is often true that the best investments are those that have previously done the worst.

He goes on to point out that in “1980, bonds had been through a 30-year bear market relative to stocks, inflation was soaring, yields were at historic highs, yet expected to go higher, and a long bull market in bonds was at hand.”

The idea that US interest rates would be near all-time lows 30 years later would have been dismissed as ludicrous. The situation is now reversed, with stocks having underperformed bonds for decades.

The point here is simple: US large capitalisation stocks represent a once-in-a- lifetime opportunity in my opinion to buy the best quality companies in the world at bargain prices. The last time they were this cheap relative to bonds was 1951.”

This relative valuation is unlikely to change in the weeks or even months ahead, but longer term investors will be making the necessary switches to their portfolios.

Please feel free to contact us directly, if you would like one of our advisors to look at your local and offshore investment portfolios, providing specific recommendations.

US jobs data boosts global markets

Noon on Monday saw the JSE All Share up 0.41%, led by gains in gold mining and oil and gas shares after global equities were boosted by Friday's better-than-expected US nonfarm payrolls data.

The rand was trading at R7.19 to the US dollar, weakening slightly by midday though still near last week’s highs remaining within a range.

Brent crude cost $76.37 a barrel, rising 1.38% despite earlier falls due to the end of the US driving season and high inventory levels that suggest weak economic recovery.

International markets

On Friday, the Dow Jones climbed 1.24% while the tech-heavy Nasdaq rose 1.53% as US markets gained on a better-than-expected labour market report.

The Japanese Nikkei closed 2.05% higher this morning, rising for a fourth session after lower US job losses last month buoyed hopes of a stronger economic recovery in their main export partner.

Though trade was thin due to US markets being closed for a public holiday today, European equities rose after Friday’s positive jobs data from the US. France’s CAC40 had risen 0.51% and Germany’s DAX had gained 0.33% by noon.
Britain's FTSE 100 had inched up 0.45% by midday, led by gains in banks and commodity stocks as risk appetite rose on the back of positive US economic data.

Share price news

Amalgamated Appliance Holdings Limited (share code: AMA) climbed 3.83% to sell at R1.90 a share, after investors sold 447 834 shares in 21 deals by 12:00. AMA released their reviewed consolidated results this morning that announced an increase in EPS and HEPS.

Alternative Trading Systems

The old style trading floors where trading in shares between buyer and seller happened in what was known as an open outcry format, has for the most part around the world been replaced by electronic order books operated by the exchanges themselves.

Most investors have heard about London Stock Exchange and the Deutchse Bourse, but most would not heard about Chi-X and BATS, which are known as alternative trading systems (ATS).

Alternative Trading Systems are non exchange trading venues, but approved by the regulators, where buyers and sellers can execute trades in existing financial instruments such as shares, bonds, and futures.

Chi-X Europe was created as a response to the EU’s Markets in Financial Instruments Directive (MiFID), which aimed to increase competition and drive down the cost of trading in Europe.

Technology allowed the creation of this trading operation in March 2007, which initially started trading just ten stocks. Now this operation traded almost 500 billion euros in the second quarter of this year and is steadily increasing market share.

BATS Global Markets operates the third largest US equity market. The name stands for Better Alternative Trading System. Started as a private company in Kansas, it is owned by a group of users including Bank of America, Citigroup, Credit Suisse, JP Morgan Chase, Morgan Stanley etc.

At the same time that regulation created the environment for these competitors to enter the market and thrive in a relatively short period of time, they themselves are also looking to possible consolidate and so enhance economies of scale. Bats is looking at a possible merger with Chi-X, which has many of the same shareholders in common.

This business began trading stocks in 2006 and says that it accounts for around 10% of US equity volumes, competing with the New York Stock Exchange and the NASDAQ.

These trading platforms have challenged the traditional stock exchanges by offering lower fees and faster trading.

Traditionally stock exchanges have been excellent businesses given near monopoly status. In South Africa the JSE, first a mutual business, before demutualising as a company for gain, and then listing itself on its own exchange, has operated with no real competition. It has a market capitalisation of nearly R6 billion and is therefore a sizable company.

In the years to come, its traditional hold and role may well change given the rapid rise of alternative trading systems around the world.

Global markets rise tentatively before US payroll data

Local markets

On Friday, the JSE All Share had risen 0.2% by midday, in line with global market movement after positive US economic data. However, an element of caution remained before the release of US jobless data this afternoon.

The rand was exchanging at R7.22 to the US dollar at noon, as rising appetite for risk showed in strengthening emerging market currencies.

Gold cost $1 253.40 an ounce, edging up 0.17% at 12:00 with physical buying tentative before the announcement of US unemployment data.

Market Returns

It is always interesting to note the returns of the different asset classes at the end of the month. The graph below illustrates the cumulative returns of the last 12 months of the Bond, All Share Equity, Listed Property and Cash indices. It was a surprise to the market how the listed property market has performed, especially over the last quarter.

The graph below illustrates the cumulative returns of the Global Bond, World Equity, Emerging Equity Markets and the Listed Real Estate indices in US dollars. It was no surprise that the emerging market outperformed the developed market over this period. Structurally the emerging economies are supported by stronger fundamentals.

During the recent six months we noted again the flight to “safety assets” (driven mostly by the US bonds). This resulted in a strong positive return by the Global Bond Index over this period.

The graph below illustrates the cumulative returns of some of the equity managers we track.

There has been quite a variation in the returns by the managers. This can be mostly attributed to their allocation resources, financials, and industrials and also to large, mid, and small companies. The graph below illustrates the relative performances of the three main sectors.

Naturally it is important to understand where you came from but more important where you are going to. This is true not only in life but also in investing.